Government Currency

Government currency consists of noninterest-bearing notes issued by the government in denominations suitable for monetary purposes and payable to bearer on demand. They may be convertible, that is, redeemable in commodity money (usually gold or silver coin or bullion); but generally they are inconvertible, that is, not so redeemable. Even when convertibility is specifically promised, experience shows that it cannot always be relied on in time of need. This is so because, as a practical matter, any substantial effort to convert is met with refusal on the grounds of emergency and national interest.

Inconvertible credit currency, however, unquestionably carries the obligation of the government for redemption, but the time of redemption is left for future determination. Such currency is thus for all practical purposes on a fiat basis; this means that it depends on government "say-so" and on public acceptance for its value and usage. Its proponents correctly maintain that fiat currency is more economical than commodity-backed currency because, obviously, it is less expensive to produce than silver or gold. They also properly point to the great flexibility of paper money.

But the disastrous experiences of overissue in some countries using fiat currency in the past pointedly demonstrate that strict control over such issues must be utilized so that the currency available matches the nation's economic needs. Otherwise serious inflation can develop.

Convertible government currency, or representative money, may simply be a negotiable "warehouse receipt" showing the deposit of a specific quantity of a commodity, as was the gold certificate ("yellowback") in the United States up to 1933 and the silver certificate up to 1963. Or it may be merely the promise of the government to redeem in specie or coin upon demand. Or it may be the promise of the government to convert the currency upon demand at a stipulated rate into a draft drawn on another country and payable in the gold-backed currency of that country.

But, whatever the promise, it is impossible for all holders to convert to gold, or silver, or whatever the convertible option may be, at the same time. In fact, convertibility is always designed in a way that prevents that contingency. Currency, or paper money, is in a sense largely a "fiat" money because it rests primarily upon faith in the character and integrity of the issuer.

The United States notes originally issued to help finance the Civil War and commonly called "greenbacks" are an example of an inconvertible currency issue. Greenbacks later achieved parity and general acceptance through the protection of a special gold reserve held in the Treasury.